Click here for Through A Trader’s Eyes Podcast #4 – January 29, 2010.

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On Friday morning, one of my favorite pieces of economic data was reported much better than expected.  The GDP Growth Rate (Quarter over quarter annualized) was reported at 5.7% vs. a 4.7% estimate.  This is also much higher than the last report of 2.2%.  Below is the S&P 500 (blue line) and the GDP growth rate (red).  This is one of the few economic indicators that is actually correlated with stock prices.  This indicator measures not how big our economy but the rate of change of growth.  Investors buy or sell stocks based on whether or not the economic growth is accelerating or decelerating.

You can see above that since 1998, the stock market has been very correlated to this number.  The stock market bottomed in March 2009 before the economy actually started to accelerate but leading economic indicators at the time were pointing in that direction.  It’s been up ever since.  In 2009, I was on television several times using a number of 5%+ for GDP growth.  Some agreed with me but most were shocked that I would say such a thing.  Here we are now in early 2010 with a reading of almost 6%.  I anticipate this number will peak at some point and start to head the other direction.  I could look similar to the 2004 & 2005 time frame.  The economy was accelerating in 2003 then began to slow down.  The are a few differences this time versus 2004.  First, the economy this time has expanded at a much faster clip and secondly I don’t believe this is the beginning of a multi-year bull market.

At the end of the day, the economy will begin to slow.  It will keep growing but just at a slower pace and I think the stock market will follow with more of a sideways choppy pattern.  But, for now, enjoy the better than expected report and potentially an oversold bounce.

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The Nasdaq has fallen almost 6% from its recent high after outperforming for most of 2009.  The weakness started after Intel reported great earnings and the stock essentially went nowhere.  Then, we had IBM’s earnings.  Same thing.  Last night, we had Apple report earnings and Amazon will report later in the week.  Is the Nasdaq ready to bounce?

You can see from the picture above of the Nasdaq that the breakout we had in late December around 2200 has held in the last two days.  I think the combination of Apple’s earnings, the big Apple release tomorrow, and Amazon’s later in the week could provide a bounce.  Technology is really hitting on all cylinders right now.  But, the market was very overbought when Intel & IBM announced their earnings a few weeks back setting us up for a fall.  We have gone from overbought to oversold in just a few days.  There are definitely some negative fundamental issues to deal with.  But, technology to me is still the place to be.  Perhaps shorting weaker areas like financials against technology makes sense.  I believe the excellent fundamental news and the trickle down from the Windows 7 release will lift tech at some point soon.

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I’m pleased to announce that I published a new podcast today.  I will be improving the quality and it should be available on Itunes very soon as well.  I hope you enjoy.  JUST CLICK HERE.  Also, go to Karl’s podcasts on the right side of the home page.

Most of you know that I’m not a big fan of buying or selling stocks based on P/E levels.  But, I do like to look at them in conjunction with several other indicators to see where they are based on history.  Below is a picture of the S&P 500 (white) with the P/E ratio (price divided by earnings) (green).  According to Bloomberg, the P/E ratio on the combined 500 companies in the S&P is currently 24.55.  Now, most analysts when discussing the P/E ratio use the forward looking P/E.  I think generally that helps them justify in buying expensive stocks at current prices.  They’ll say things like “the P/E ratio based on 2012 earnings…..”  You’ll see from the picture below that the estimated P/E is around 15.  Higher earnings, lower P/E.

In March last year, the P/E ratio went below 10 making stocks cheap.  Yes, actually cheap.  But, are they cheap now?  The graph above goes back to 2004 and you’ll see the P/E ratio averaged about 16 until October 2008.  What’s interesting is that the P/E ratio didn’t go up for the last several years even though the S&P 500 itself was reaching new highs.  In a nutshell, earnings (profits) were keeping up with prices so higher prices were justified.   Obviously, a consistent P/E didn’t stop the market from crashing which is why P/E ratios aren’t the best indicators for valuing stocks.  Now, look at the graph from March 2009 until present and you’ll see that the P/E ratio has been rising at a faster rate than the stock market.  So, stocks are becoming more and more expensive.

So, why aren’t people selling stocks based on this?  It all goes back to what I said at the top.  Investors buy stocks or sell stocks based on the future expectations and cash flows.  And they buy or sell stocks based on their willingness or unwillingness to assume risk.  Most expect earnings this year will be higher which means stocks aren’t as expensive as they seem.  The problem is that I don’t have confidence in any analyst that can tell me how much the earnings of the S&P 500 will be in 2010.  They don’t even know how much earnings will be next month.

This isn’t a call for you to run out and sell stocks.  But, continue to watch what companies are saying and what they are reporting.  If earnings don’t improve as expected, stocks will begin to fall (see Whole Foods & Starbucks a few years ago when their stocks were priced for perfection).  There’s no sign just yet this stock market has topped but certainly stocks aren’t cheap.  With that said, it’s too early to tell if they are too expensive.  As usual, pay attention.

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In the past few days, the news headlines have been dominated by financials and technology.  First, there are new taxes being proposed on financial firms.  We bailed them out and now it’s payback time.  At least, that seems to be the attitude in Washington.  No more too big to fail.  Then, we have earnings.  Several financial firms are reporting their earnings in the next few days.  JP Morgan kicked it off this morning.  As a group, financials have performed pretty well this year.  But, besides financials, technology have also been the talk of the town.  Smartphones were extremely popular for Christmas gifts and with Windows 7 causing a technology upgrade, these stocks have done very well also. Then, we get word that Google wants to pull out of China because they are concerned about the Chinese government hacking into their systems.  Other American companies admit the same but have been too scared to say anything in fear of losing business in China.  All of this news in the financial & tech industries has caused investors to forget about some of the sectors that dominated the front page in 2009.

Gold, which was up about 25% last year, is off to a good start in 2010 as well but isn’t getting the headlines and I believe it’s on the verge of a big move.  The dollar, which had a nice run late in the year has given back almost half of its gains but it’s not newsworthy anymore apparently.  I think it’s still very relevant as are interest rates and gold will certainly be a mover in 2010.

You can see from the picture above that gold has been making higher lows for some time but has just recently been making lower highs as well.  Something will give and I think it will be soon, just like sugar late last year.  With the stock market overbought in the short-term, investors may look to re-allocate to another asset class and gold could be it.  I’m bullish on lots of different metals but I wanted to highlight gold since I get so many questions about gold generally.

Intel’s strong earnings on Thursday weren’t that big of a surprise given the fact that Windows 7 is now firmly in place.  After the bell, Intel beat sales & earnings expectations giving the stock a boost.  Barring some short-term pullbacks, this clears the way for higher prices for tech in general.  Windows 7 was released last fall and it’s beginning to trickle through tech land, just like low interest rates and stimulus trickled through the financial system.  Most businesses I know still use Windows XP and skipped Vista all together.  Vista looked different and acted different but was too unstable to run a business on.  In addition, many vendors of software that I used simply weren’t compatible with Vista.  Windows 7 is now Vista without all the bugs.  It’s more secure than XP and basically it’s just time to move on.  It’s becoming harder and harder to even find a new computer installed with Windows XP.  Businesses now have a reason to upgrade.  Microsoft was the bowling ball and some of the pins are Intel, Marvel Technologies, Sandisk, Applied Materials, Texas Instruments, etc.  I expect more strong earnings from these guys as well over the next few weeks.  IBM announces their earnings on the 19th and they should be excellent.  You can get fancy owning individual companies but I still like the ETFs in this space like IGM & XLK.

With strong tech results coming, stronger bank results would add even more life to this impressive bull market.  JP Morgan, Wells Fargo, Citigroup, Morgan Stanley, & US Bancorp all report over the next few days.  Strong results from the financial sector give investors that were hesitant another reason to buy.  As I see it right now, there’s simply no sellers.  Any bad news is being ignored and investors are focusing on low rates, an improving economy, and better news from companies.  I would caution those of you that are under invested and dying to get into this market.  I would be patient and average in because while the light is still very green to buy stocks, the short-term is getting a little overheated.  A lot of sectors and stocks are participating in this rally which is very bullish, but bull markets pause and breathe.  So, in the short-term, be guarded but this bull market isn’t done yet.